The Path to Market Growth: Acquire or Build

So you’re eyeing that potentially lucrative new market or complementary product line, and the question inevitably arises: is it better to build a new business unit from scratch or buy it by acquiring a company already operating in the space?

Each strategy has its own risks and rewards, and each could make sense depending on factors both internal and external. Here are the factors to consider:

Goals. Before contemplating an acquisition - or even organic growth into new markets - make sure that the move drives you toward your long-term business strategies, says Edward Hess, professor of business administration at the Darden Graduate School of Business at the University of Virginia and author of Grow to Greatness: Smart Growth for Entrepreneurial Businesses.

Where are the opportunities for future market growth? Are there specific geographies or customer segments that remain under-served? Who’s there already? What is your value proposition, and how can you defend your market position? Most importantly, who is your target customer? How can you find more of them, and how can you sell more to them. If the clear answer is through acquisition, then you can begin the process of seeking an appropriate target. But what about acquisition opportunities that surface opportunistically? In that case, tread carefully. “Too good to pass up” is a terrible rationale for investing in a new enterprise.

Risk. Any discussion of acquisition has to begin with the fact that they are fraught with risk. “The research shows that most acquisitions do not create value for the buyer,” Hess says. Why is this so? Because no matter how thorough your due diligence (and unfortunately, it is rarely as thorough as necessary), there are always unknowns lying under the hood.

“Most acquisition negotiations are dances,” Hess adds. “The buyer is trying to learn what it is really buying, and the seller usually has unspoken reasons for selling.” What’s more, it’s easy to overestimate potential synergies, and underestimate the difficulty in merging operations and culture.

Opportunity. Hess suggests that few companies, regardless of size, ever exhaust the potential organic opportunities for market growth - opening a new location, say, or developing complementary products in-house - before turning to acquisition. “In many cases, you don’t have to make the choice to buy or build. It’s easier to add on services to your offerings, or resell complementary products rather than buy the company making them.” While he believes there is a place for strategic acquisition, it is only after these possibilities have been exhausted that companies should consider buying another.

Timing. Given the risks, such a strategic acquisition can mean speedier entry into new markets; the wholesale acquisition of talent, intellectual capital and technology; or the elimination of a competitor. Timing also plays into the price and availability of acquisition targets: the more strategically significant the position the target company holds, the higher the premium you’re likely to pay. This may be particularly true in fields such as technology, which undergo rapid and transformative evolution.

Cost. Take a look at the financial implications of build vs. buy. What impact will an acquisition have on your balance sheet? How quickly will you be able to recoup your investment and, more importantly, how will you be able to bring value to that acquisition, and see a clear return? If you’re growing organically, how will that impact your cash flow? What financing should you have in place to mitigate the risk of a cash crunch?

Finally, it’s worth taking a look at your core competencies. Do they include the skills needed to execute a successful merger? “Ultimately, the choice between organic market growth and acquisition is a strategic analysis weighing risks, probabilities of success, and your competitive position,” Hess cautions. “Remember that unless you have strong due-diligence and merger-integration capabilities, buyer beware.”

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